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ECONOMICS • MACROECONOMICS

Aggregate Demand,Aggregate Supply Shocks

Shift aggregate demand, expected prices and supply conditions to see how short-run output, the price level and the output gap respond.

● MACRO SHOCK MAPAD ↔ SRAS ↔ potential output
Output
Price level
Output gap
Long-run price

Reasoning inspector

live model state
Output—
Price level—
Output gap—
Potential output—
Expected price—
Supply shock—

Experiment with the mechanism

Short-run macro equilibrium occurs where aggregate demand intersects short-run aggregate supply. Potential output provides the benchmark for the output gap, while expected prices and supply shocks shift short-run supply.

LEARN WITH THE SIMULATION

Understand Aggregate Demand,Aggregate Supply Shocks by experimenting.

START HERE

The aggregate demand,aggregate supply model summarizes short-run macroeconomic equilibrium in output and price-level space. Aggregate demand slopes downward in this simulation, while short-run aggregate supply depends on expected prices, a supply shock, and the gap between actual and potential output. Their intersection determines short-run output and the price level.

BUILD THE IDEA

What you should understand first

  • Separate movements in aggregate demand from shifts in short-run aggregate supply.
  • Use potential output to interpret positive and negative output gaps.
  • Explain how expected prices and supply shocks can change inflationary pressure and output at the same time.

TRY IT YOURSELF

How does an adverse supply shock differ from a demand expansion?

  1. Record the baseline output and price level.
  2. Apply a positive supply-cost shock and replay the equilibrium.
  3. Reset, then raise the aggregate-demand intercept instead.
  4. Compare the direction of output and price changes in the two cases.
Read the visual:

An adverse supply shock tends to raise the price level while lowering output, whereas a demand expansion tends to raise both output and the price level in this simplified linear model. Similar inflation outcomes can therefore come from very different real-side mechanisms.

WHY IT WORKS 01

Why supply shocks create a difficult tradeoff

A positive cost shock shifts short-run aggregate supply upward: firms require a higher price level to supply the same output. The new intersection can therefore combine higher prices with lower production. That differs from a pure demand expansion and helps explain why policymakers may face a harder tradeoff when inflation is driven by supply conditions rather than excess demand.

WHY IT WORKS 02

Expected prices anchor short-run supply

The SRAS relation is written around an expected price level. If actual prices rise above what firms and workers expected, output can temporarily differ from potential in this simplified framework. Changing expected prices shifts the short-run supply relation itself, which is why repeated surprises cannot be treated as permanently holding the economy away from potential output.

DO NOT MIX THESE UP

Common misconception

AD,AS diagrams are compact teaching models, not literal engineering curves for an economy. Potential output is uncertain, expectations can change endogenously, monetary and fiscal policy may react to shocks, and real-world aggregate supply can be nonlinear.

PRACTICE CHALLENGE

Can you create the same price level with opposite output gaps?

  • Build one scenario with strong aggregate demand and a positive output gap.
  • Build another with a supply shock and weaker demand.
  • Adjust controls until the price levels are similar.
  • Compare output relative to potential and explain why the same price level does not reveal the same macroeconomic state.
Reveal the reasoning

Yes. The price level is determined jointly by aggregate demand and short-run supply. Different combinations of demand strength, expected prices and supply shocks can produce similar prices while output lies above potential in one case and below potential in another. A price observation alone therefore does not identify the underlying shock.

MODEL BOUNDARIES

What this simulation assumes

Every simulation simplifies reality or a mathematical system. These are the assumptions and limits to keep in mind while interpreting the results.

Model assumptions

  • Aggregate demand is linear and downward sloping in output-price space.
  • Short-run aggregate supply is linear around expected prices and potential output.
  • Potential output, expected prices and the supply shock are fixed within each static equilibrium.

Model limitations

  • Expectations, policy responses, capacity constraints and long-run adjustment are not endogenized.
  • Real economies can exhibit nonlinear aggregate supply and uncertain potential-output estimates.

CONNECT IT

Where this matters

  • Macroeconomic shocks
  • Output-gap analysis
  • Demand-pull versus supply-driven inflation
  • Policy discussion

WORDS THAT MATTER

Key vocabulary

Aggregate demand
Total planned spending represented here as a downward-sloping relation between the price level and output.
SRAS
Short-run aggregate supply, represented here as an upward-sloping relation around expected prices and potential output.
Potential output
The benchmark level of sustainable output used to define the output gap.
Output gap
Actual output minus potential output.